How Are Contributions to a Tax-Sheltered Annuity Taxed?

Contributions to a tax-sheltered annuity, better known as a 403(b) plan, receive one of three tax treatments depending on who puts the money in and which account the employee uses. Pre-tax employee contributions are excluded from federal income tax the year they go in and taxed when they come out. Roth employee contributions are taxed upfront and come out tax-free if the rules are met. Employer contributions skip current taxation entirely and are taxed only at withdrawal. The mechanics behind each, along with the dollar limits that cap the tax shelter, decide how much of your paycheck the IRS leaves alone.

Pre-Tax Employee Contributions

Pre-tax contributions are the default for most 403(b) participants and the clearest example of tax deferral. You sign a salary reduction agreement, and your employer diverts part of each paycheck into the plan before calculating federal income tax withholding. The deferred money never appears as taxable wages on your W-2.

The savings land in real time, not as a refund. Every paycheck with a pre-tax deferral has less income tax withheld because the taxable amount is lower. If you earn $70,000 and defer $10,000, your W-2 Box 1 shows $60,000. The deferred amount appears separately in Box 12 with Code E.¹

One detail surprises people. The exclusion applies only to income taxes. Pre-tax 403(b) contributions are still subject to Social Security and Medicare (FICA) taxes, so your payroll tax withholding is calculated on your full salary.² That also means the contributions count toward your Social Security earnings record, which helps your future benefit calculation.

Contributions and any investment earnings grow without being taxed along the way. That tax-free compounding is the real advantage of deferral. When you eventually take distributions in retirement, the entire amount withdrawn counts as ordinary income for that year. Both your original contributions and decades of accumulated earnings are taxed at whatever bracket you fall into at withdrawal. The bet you are making with pre-tax contributions is that your retirement tax rate will be lower than the rate you would have paid during your working years.

Roth Employee Contributions

Roth 403(b) contributions flip the tax timing. You pay income tax on the money now, at your current rate, and in exchange your withdrawals in retirement are completely tax-free. Your employer does not reduce your taxable wages when making Roth deferrals, so your W-2 Box 1 reflects your full salary, including the Roth amount. The Roth deferral is reported in Box 12 with Code BB.¹

The tax-free treatment in retirement is not automatic. Your withdrawal must be a “qualified distribution,” which requires two conditions. First, at least five years must have passed since January 1 of the year you made your first Roth 403(b) contribution. Second, you must be at least 59½, permanently disabled, or deceased (in which case the benefit passes to your beneficiary). When both conditions are met, you owe zero federal income tax on everything that comes out, including all the investment earnings.

If you take money out before satisfying those conditions, the withdrawal is non-qualified. Your original Roth contributions come out tax-free regardless, since you already paid tax on them, but the earnings portion gets taxed as ordinary income and may trigger a 10% early withdrawal penalty.

The Roth option tends to make the most sense if you expect to be in a higher tax bracket in retirement than you are now. That is common for younger employees early in their careers, people anticipating pension income on top of their 403(b), or anyone who believes tax rates will rise. You can also split your deferrals between pre-tax and Roth, hedging the bet on future rates.

Employer Contributions

Employer contributions to a 403(b), whether matching or non-elective, follow the same deferral model as employee pre-tax contributions. The amounts are not included in your taxable income when deposited, and they grow tax-deferred until withdrawal.³ Unlike employee deferrals, employer contributions are also exempt from FICA taxes entirely, so neither you nor your employer pays Social Security or Medicare tax on those amounts.

Employer contributions do not get a dedicated W-2 Box 12 code the way employee deferrals do. Employers may optionally report them in Box 14, labeled “Other,” but are not required to.⁴

Your access to employer contributions may depend on a vesting schedule. If your plan uses one, you earn ownership of employer contributions gradually over several years of service. Unvested amounts that you forfeit when leaving are never taxed because you never actually receive them. Vested amounts follow the same rule as pre-tax deferrals: taxed as ordinary income when distributed in retirement.

2026 Contribution Limits

The tax-sheltered treatment of 403(b) contributions only applies up to annual dollar limits. Dollars beyond those limits lose their shelter and create real tax problems.

Elective Deferral Limit

The basic limit on employee contributions, pre-tax and Roth combined, is $24,500 for 2026. This ceiling applies per person, not per plan. If you contribute to both a 403(b) and a 401(k) with different employers, your combined elective deferrals across all plans cannot exceed $24,500.⁵ Governmental 457(b) plans have a separate limit and do not count toward this cap.

Catch-Up Contributions

Three catch-ups can push your deferrals above the base limit:

Age 50+ catch-up. If you turn 50 or older by December 31, 2026, you can defer an additional $8,000, for a total of $32,500.⁵
Age 60–63 “super” catch-up. Under the SECURE 2.0 Act, participants who are 60, 61, 62, or 63 at year-end can contribute up to $11,250 in catch-up contributions instead of the standard $8,000, for a total of $35,750.⁵
15-year service catch-up. If you have worked for the same qualifying 403(b) employer for at least 15 years, you may defer an additional amount up to $3,000 per year, subject to a lifetime cap of $15,000. Eligible employers include public school systems, hospitals, home health service agencies, health and welfare service agencies, and churches. The actual amount also depends on your average past contributions, so it is not always the full $3,000.⁶

When an employee qualifies for both the 15-year service catch-up and the age-based catch-up, the 15-year amount is applied first.⁷

Overall Annual Additions Limit

A separate, higher ceiling under Section 415(c) caps the combined total of all employee deferrals, employer matching contributions, and employer non-elective contributions at $72,000 for 2026.⁵ Age-based catch-up contributions are excluded from this calculation, so the $8,000 or $11,250 catch-up sits on top of the $72,000.⁸ Your employer is responsible for monitoring this limit and issuing correct W-2s.

What Over-Contributing Costs

Exceeding the $24,500 elective deferral limit is one of the costliest mistakes you can make with a 403(b). The excess amount is taxable income in the year you contributed it, regardless of whether it was designated as pre-tax. To fix the problem, the plan must distribute the excess deferral and any earnings it generated by April 15 of the following year.⁹

If that April 15 deadline passes with the excess still in the plan, you face double taxation. You already owed tax on the excess for the contribution year, and you will owe tax again when the money eventually comes out as a distribution. The IRS does not forgive one just because you paid the other. This is where people who contribute to multiple employer plans get caught most often, since each employer tracks only its own plan and nobody flags the combined overage until you file your tax return.

Mandatory Roth Catch-Up for Higher Earners

Beginning in 2027, the SECURE 2.0 Act requires that catch-up contributions made by higher-income participants go into a Roth account. If your FICA wages from the employer sponsoring the plan exceeded the inflation-adjusted threshold (currently $145,000, indexed annually) in the prior calendar year, all of your catch-up contributions must be designated Roth.¹⁰ Pre-tax catch-up contributions will no longer be an option for affected employees.

Plans can voluntarily implement the rule earlier using a “reasonable, good faith interpretation” of the statute, so some employers may already require Roth catch-ups in 2026.¹⁰ There is a practical wrinkle. If your 403(b) plan does not offer a Roth option at all, affected employees simply cannot make catch-up contributions. Ask your plan administrator now whether your plan has adopted a Roth feature.

Who Can Participate

Only certain employers can offer a 403(b) plan. Eligible sponsors include public schools, colleges, and universities; churches and church-related organizations; and charities and other entities that qualify as tax-exempt under Internal Revenue Code Section 501(c)(3).¹¹ Employees of cooperative hospital service organizations and certain ministers also qualify.¹² If your employer is a private, for-profit company, a 403(b) is not available to you; those employers typically offer 401(k) plans instead, and the tax treatment above does not apply to your situation.

1
Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3
2
Internal Revenue Service. Retirement Plan FAQs Regarding Contributions – Are Retirement Plan Contributions Subject to Withholding for FICA, Medicare or Federal Income Tax
3
Office of the Law Revision Counsel. 26 US Code 403 – Taxation of Employee Annuities
4
Internal Revenue Service. Publication 571 – Tax-Sheltered Annuity Plans (403(b) Plans)
5
Internal Revenue Service. Retirement Topics – 403(b) Contribution Limits
6
Internal Revenue Service. 403(b) Plan Fix-It Guide – An Employee Making a 15-Years of Service Catch-up Contribution Doesnt Have the Required 15 Years of Full-Time Service with the Same Employer
7
Internal Revenue Service. 403(b) Plans – Catch-up Contributions
8
Internal Revenue Service. 403(b) Plan Fix-It Guide – Your 403(b) Plan Doesnt Limit the Total Employer and Employee Contributions to Not Exceed the IRC Section 415(c) Limits
9
Internal Revenue Service. 403(b) Plan Fix-It Guide
10
Internal Revenue Service. Treasury, IRS Issue Final Regulations on New Roth Catch-up Rule, Other SECURE 2.0 Act Provisions
11
Internal Revenue Service. IRC 403(b) Tax-Sheltered Annuity Plans
12
Internal Revenue Service. 403(b) Plan Fix-It Guide – Your Organization Isnt Eligible to Sponsor a 403(b) Plan